Why you should take money at the maximum normal level

Almost every day I talk with entrepreneurs and other venture capitalists about fundraising, transaction and stock prices, how companies should borrow money, etc. In fact, I try to discuss these things less and less publicly, because it is such a hot and emotional topic, where there can be a huge number of points of view and all of them are strictly subjective, and only time gives answers to most of the questions.

Nevertheless, I decided to collect all the private positions in one topic and publish them in one place, as well as present them as a performance from the stage on June 15 as part of the Founder Showcase , held in San Francisco.

One of the topics I will raise right now. This is a little advice that I most often give to budding entrepreneurs: "take money at the maximum normal level."

Here is what I mean.

Each company has a certain value. At the public securities markets, this value is determined by the importance that investors attach to the future value of free cash flows , discounted to the current date, for the temporal to the second value of money . From this complex formulation, a fairly simple fact follows - the older the company itself, and the area of ​​the economy (industry) in which it operates, the easier it is to predict its future.

When investors are confident about the future of a company, they inflate its value due to the growth of perception, the subjective feeling that the future profit of this company, and the industry, will be appreciated by other investors. Therefore, the capitalization of publicly traded companies changes almost instantly, reacting to news that can change the future valuation of this company, that is, the profit.

Every day, shareholders vote on the value, that is, the value of the company, by buying or selling its shares. There will be no price movement until one person agrees to sell the stock and the other agrees to buy it. Traditionally, shares of companies traded by a large number of people are called liquid- which in general means that entering the company (buying shares) and leaving it (selling shares) is relatively easy.

Private or closed securities markets are the opposite. They are quite illiquid. If you invested in a young company during the angelic round , then it will usually be very difficult to sell the shares that you received in the end - as a rule, it takes several years, if you can sell them at all. So how are prices determined in such events?

There is no complicated science here. The sooner you invest, the higher the chances that the company will not work out in the end (your risk is very high), plus do not forget that you pay much less money per share than investors of later stages. As an investor, you are trying to pay an adequate price for the perceived risks during the growth of the company - its path to success, as well as protecting yourself from unnecessary expenses that arise if, for example, you overestimate the company (it cannot yet evaluate itself). With the reduction of these risks, the company's valuation, its value, as well as the amount of money that investors are ready to give, increases.

Illustration No. 1, vertical vector: cost estimate . Horizontal vector: time . From left to right, risks: product risk, Market risk , the risk of growth , the risk of monetization / competition .

Over time, some norms appeared in the valuation of companies based on investor risk and return on investment profile. The obvious thing is that every investor is thinking about how to increase their own investments made in this or that company. People who invest in technology startups in the early stages are looking for companies that are focused on rapid growth and are able to once “exit” - either let the giant working in the same industry absorb themselves, or make an initial offer (the notorious IPO). Moreover, the former, as a rule, is more probable than the latter. For this reason, most investors have certain ideas about which companies, similar to yours, usually participate in M&A transactions, and they also have, or at least should have,

Consider an example: if you had to invest $ 41 million in a company (again, suppose that your share in this case would be in the range from 33% to 50%), then the valuation of such a company would be in the plane of $ 82-123 million. As an investor at an early stage, you usually plan to increase your initial investment (to exit) by 10 times, compared with the amount on the first check, so you will expect the company to exit in the plane from $ 800 million to $ 1.2 billion. Then, after doing a little research, you find that literally a few companies have ever been bought for this amount of money, so your investment is made unambiguously on an IPO. It is unlikely that you will want to make such an investment in a product, or a market that has not yet consolidated (that is, does not have a strong position in the economy),

But after all, if there is a statement that with an average amount of funds (the amount on the check) in the angelic, or the first (A) round of investment , you should not worry about the exit, because if you get into the stake really early and at a low price - what difference does it pay you $ 5 million according to preliminary estimates or $ 15 million according to preliminary estimates - is it important that you invest in really big / fast-growing companies? Well, it is obvious that if you know in advance that the company will be large, this statement is an unconditional truth. But the reality is that you will immediately have to face two problems:

1. The earlier the stage, the higher your risks, and the greater the share you have to have in your pocket in order to win back at the expense of the losers (note: the law of the financial market is this: when someone wins, someone loses) .
2 . The earlier the stage you finance, the higher the likelihood that the company will need a few more investment rounds, which will blur your share in the company.

Illustration No. 2, vertical vector: round / cost estimate , horizontal vector: time . At the peak: hot companies / booms , at the bottom: medium companies / failures .

Each round will be evaluated in a certain range limited by floating levels, where prices at the peak characterize the most successful companies in the industry, or an overheated market (2007, 2011), and prices at the bottom describe not the most successful years for investment (and fundraising) (2003 , 2008).

Do not forget that there is no such thing as a “universal price”. The cost of each investment depends on many factors: the experience of the team, the type of business and industry (so round A of a semiconductor or bio-fuel company will be very different from round A of an Internet company), geographical location, etc. Therefore, the range you can expect will never be accurate. But in order to explain this in more detail, I will show examples of typical preliminary estimates of Internet companies in the largest markets in the United States (San Francisco, New York, Los Angeles, etc.), not forgetting that in San - Francisco transactions are usually performed at higher ratings due to close competition between investors.

Illustration 3: A normal market is neither bearish nor bullish. Vertical Vector:rounds / valuation . Horizontal vector: time . After curly brackets, the amount of funds received by the company at different cost estimates.

This is my value judgment and I did not conduct any negotiations with anyone before putting the figures on the illustration. I show the approximate price range that I saw in the valuations of Silicon Valley companies, as well as New York, Los Angeles, Boston, Boulder and Seattle. The figures are based on my personal experience, and I'm just trying to clarify the eternal question of entrepreneurs about what is happening in the market. Plus, there are always exceptions - you should not forget about them.

In 2011, prices rose uniquely, as shown in the graph below. Amounts are expressed in preliminary estimates of the value, that is, before the investment.

Illustration 4: Bull Market Prices. Vertical vector: rounds / cost estimate . Horizontal vector: time .

Personally, I believe that investors need to accept the objective reality of how pricing is happening today in order to remain competitive in the current market, in the current conditions. As always, prices are determined by standard factors: the quality of the team, the quality of the product or market, as well as the competitiveness of the transaction itself.

Therefore, when I tell entrepreneurs that it’s quite normal to try to shoot at the “maximum normal level”, I’m talking about the current market. In 2011, as a startup, you can generate huge demand, and you can undoubtedly receive, say, $ 3 million in round A with a preliminary estimate of the cost of $ 7-8 million, or even higher, which a couple of years ago seemed simply fantastic. This is normal today. This is what happens when you raise funds in a healthy and good market to finance your company.

What I warn all entrepreneurs against is getting money at value levels that are obviously higher than they actually are. I myself am a venture capitalist, and you might think that my logic is dictated by this very fact, but in reality this is not so. I have been preaching the idea that there is no need to get ahead of my current grades for the past 10 years. I received the first funds in a post-investment valuation of $ 31.5 million, in financing round A, even without any profit. It was the beginning of 2000. It was the then market. I first saw such estimates when I first entered this market in 2007. Later, many non-profit companies came to me, and they all received $ 10-15 million with a preliminary estimate of $ 40-50 million. It’s worth noting here that although they had a product,

We always missed such deals, although we often tried to conduct a dialogue on smaller investments, with more realistic cost estimates. But stopping the train is very difficult. One company raised money at a preliminary estimate of $ 40 million, and one of its representatives wrote about me at a public forum that: “Mark worked very hard and tried to understand our business, as well as scrupulously treats all the details. But he and his company simply did not appreciate us. ” Well that's fair. But they sold their business in less than 3 years, not for very big money, almost immediately after they received the next batch of investments worth $ 20 million. Another company in our field of view was trying to get $ 15 million with a preliminary estimate of $ 60 million, having similar dynamics. They had a closed round,

This is the problem. If you do not have a tangible product or market, you still have a very risky business, and you double the risk by overestimating your own value. If you get money at a preliminary estimate of $ 40 million, although in a normal, not overheated, market, you would not have cost more than $ 15 million - you pi% $ ec, because the market will adjust and you will need another round. In this situation, for any investor you are already a loser. Even if you have a super interesting story, most investors will not want to listen to this dregs because of a potential “ round down ” (when late investors invest at a lower price compared to the original ones, that is, the cost estimate falls).

Finally, even if they agree to this in order not to lose their money at all and will offer you such a round, a smart investor will always know that it is “fools gold”. He will get a lower price, tear you to pieces by taking huge shares, because It forces you to give up b about proc eed part of their own business. And you take this money - do you have a choice? After a maximum of 2 years, you will already be planning the creation of the next startup. And the CEO, whom they will have to hire in order for the business to somehow function, will certainly be a mercenary from another industry. In general, you understand.

Therefore, here is my advice to you: go and look for money with estimates that seemed unlikely a couple of years ago. Use market competition to understand your honest (it doesn’t meanreal , it means fair ) value. Get more than you could or did before, but be sure to leave some of the money as a strategic reserve. Make sure that if you have to spend another round, you can show the growth of the value of the company so that the new investor feels calm and maintains good relations with earlier investors.

Raise the price. But as long as you are not a very well-known technology giant, such as Facebook or Twitter, be wary of evaluations outside the normal range normal for a bull market. If you are popular, don’t take it like everyone else. Take at the maximum normal level.